Does Running The Financial System Cost Too Much?

Is the mechanism for moving capital -- the modern financial system -- worth the price we pay for it?

Probably not, says Benjamin Friedman, an economics professor at Harvard and author of The Moral Consequences of Economic Growth.

FT: Aside from the recession, it is important to ask what this once-admired mechanism costs to run. If a new fertiliser offers a farmer the prospect of a higher crop yield but its price and the cost of transporting and spreading it exceeds what the additional produce will bring at market, it is a bad deal for the farmer. A financial system, which allocates scarce investment capital, is no different.

Friedman makes a couple of points.

One is the old argument that too many talented young people chose careers in finance and add very little value to the broader economy despite their high salaries. "The largest individual returns seem to flow to those whose job is to ensure that microscopically small deviations from observable regularities in asset price relationships persist for only one millisecond instead of three," he says.

Second, and more broadly, he says the financial sector's huge 34% share of all profits earned by U.S. corporations -- during the first half of the decade (obviously, it'd be a lot less than that lately) -- makes whatever economic growth it produces hard to justify:

What makes a more efficient financial system worthwhile is not just that it allows us to achieve greater production and economic growth, but that the rest of the economy benefits. The more the financial system costs to run, the higher the hurdle. Does the increased efficiency our investment allocation system delivers meet that hurdle? We simply do not know.

That being said, the financial crash is basically all you need to validate Friedman's argument. We know the system was too expensive, providing too little value, because it all came tumbling down. And in retrospect, the most obvious evidence that all of the supposed "innovation" in the sector wasn't all it was cracked up to be, was that the innovations fattened, rather than thinned, industry-wide margins.